Are Americans Undertaxed?

According to the Tax Foundation, Tax Freedom Day “is the day when the nation as a whole has earned enough money to pay its total tax bill for the year.” Tax Freedom Day “takes all federal, state, and local taxes and divides them by the nation’s income”; that is, “every dollar that is officially part of net national income according to the Department of Commerce’s Bureau of Economic Analysis.” For the last two years, Tax Freedom Day has fallen on April 16, 105 days into the year. Tax Freedom Day for those living in high-tax states such as New York, New Jersey, and Connecticut actually came later, just as Tax Freedom Day arrived sooner for those living in states with lower taxes such as Alaska, Oklahoma, and Florida. During 2019, Americans paid “$3.4 trillion in federal taxes and $1.8 trillion in state and local taxes, for a total bill of over $5.2 trillion, or 29 percent of the nation’s income.” Americans collectively spent “more on taxes in 2019” than “on food, clothing, and housing combined.”

Yet, late last year, the Wall Street Journal (WSJ) was practically declaring that Americans are undertaxed. “Trump’s Tax Cuts Push U.S. Burden Lower in World,” was the headline of one article. “The U.S. Now Has One of the Lowest Tax Burdens in the World,” said the headline in the WSJ’s newsletter on the economy. Both articles refer to a report by the Organisation for Economic Co-operation and Development (OECD), and both articles reference The Tax Cuts and Jobs Act (the TCJA, or Trump tax cut).

The OECD report

Founded in 1961, and now consisting of thirty-six member countries, most of which are in Western Europe, the OECD “is an international organisation that works to build better policies for better lives.” Its goal “is to shape policies that foster prosperity, equality, opportunity and well-being for all.” The OECD draws on “almost 60 years of experience and insights to better prepare the world of tomorrow.” It works with “governments, policy makers and citizens” to establish “international norms” and find “evidence-based solutions to a range of social, economic and environmental challenges.” This ranges from “improving economic performance and creating jobs to fostering strong education and fighting international tax evasion.” The OECD member countries “regularly turn to one another to identify problems, discuss and analyse them, and promote policies to solve them.”

Late last year, the OECD issued “Revenue Statistics 2019: Tax Revenue Trends in the OECD.” This is an annual publication that “gives a conceptual framework to define which government receipts should be regarded as taxes.” It presents “a unique set of detailed and internationally comparable tax data in a common format for all OECD countries from 1965 onwards.”

In 2018, the average OECD tax-to-GDP ratio remained virtually unchanged compared to 2017, with almost no increase (a change of 0.02 percentage points). This ends the trend of annual increases in the OECD average tax-to-GDP ratio observed since 2009, following the financial crisis. The slowing in the growth of the OECD average was predominantly driven by the impact of the significant fall in the tax-to-GDP ratio of the United States as a result of their tax reforms.

Fifteen countries experienced a decrease in tax-to-GDP ratios in 2018 relative to 2017. The largest fall was seen in the United States (2.5 percentage points), following the reforms to corporate and personal income taxes and the one-off repatriation tax on foreign earnings implemented in the Tax Cuts and Jobs Act.

And, as pointed out by the WSJ analysis of the report,

In 2018, U.S. governments collected 17.6 percent of their revenue from taxes on goods and services, the lowest in the OECD.

U.S. tax burdens dropped by the largest amount among those countries in 2018, and the U.S. now has lower taxes than all but three countries in the Organization for Economic Cooperation and Development.

U.S. taxes at all levels of government fell to 24.3 percent of gross domestic product in 2018, down from 26.8 percent a year earlier and 25.9 percent in 2016.

Measured as a share of the U.S. economy, taxes are now 10 percentage points below the 2018 OECD average of 34.3 percent.

That the U.S. tax burden, measured as the tax-to-GDP ratio, is now lower than every OECD country except Chile, Ireland, and Mexico is said to be “driven by the federal tax cut that Congress and Mr. Trump enacted at the end of 2017.” It “reduced the U.S. tax burden to one of the lowest among major world economies.” The TCJA “brought the U.S. tax code from one of the least competitive to one of the most competitive in the world,” said Rep. Kevin Brady (R-Tex.). “We have to continue this work to improve our tax code to remain the world’s most competitive economy.”

The Trump tax cut

According to the WSJ, “The 2018 data mark the culmination of nearly two decades of tax-cutting in the U.S., starting with President George W. Bush’s tax cuts in 2001 and 2003.” Before the Bush tax cuts (the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003), governments in the United States collected 28.3 percent of GDP in taxes, “5.5 percentage points below the OECD average.” At 24.3 percent of GDP, “taxes are now 10 percentage points below the 2018 OECD average.” The main reason for this is the massive cut in the bloated corporate income tax rate by the TCJA. At a maximum of 35 percent, the U.S. corporate tax rate was for years one of the highest in the world. The top rate is now down to 21 percent.

Individual income tax rates are down as well. During the Bush years, there were six temporary tax brackets of 10, 15, 25, 28, 33, and 35 percent. In 2013, those rates were made permanent because of the passage of the American Taxpayer Relief Act. However, for those earning more than $400,000 a year ($450,000 for married couples), the top rate increased to 39.6 percent. Moreover, the estate tax rate increased, the tax rates on long-term capital gains and dividends were raised on higher-income taxpayers, and the personal exemption and itemized deduction reductions were reinstated.

Under the TCJA, there are still seven tax brackets, but the rates are 10, 12, 22, 24, 32, 35, and 37 percent. The corresponding income brackets in 2020 for single individuals (and married filing jointly) are:

10 percent: $0–$9,875

($0–$19,750)

12 percent: $9,876–$40,125

($19,751–$80,250)

22 percent: $40,126–$85,525

($80,251–$171,050)

24 percent: $85,526–$163,300

($171,051–$326,600)

32 percent: $163,301–$207,350

($326,601–$414,700)

35 percent: $207,351–$518,400

($414,701–$622,050)

37 percent: $518,400+

($622,050+)

The standard deduction is $12,400 (single) and $24,800 (married filing jointly). The TCJA eliminated personal exemptions, although there is now a $500 credit for each non-child dependent such as a child 17 or older, an elderly parent, or an older child with a disability. The Child Tax Credit is worth up to $2,000 per qualifying child. The tax rates on long-term capital gains are 15 percent on income exceeding $40,000 ($80,000) and 20 percent on income exceeding $441,450 ($496,600). The estate tax rate is 40 percent, but only on estates valued at more than $11.58 million ($23.16 million). And then there is the Net Investment Income Tax (NIIT), which taxes investment income — including interest, dividends, capital gains, rental and royalty income, and non-qualified annuities — at a rate of 3.8 percent on investment income exceeding $200,000 ($250,000 married filing jointly).

According to an analysis of the TCJA by David Stockman, Ronald Reagan’s director of the Office of Management and Budget (OMB), “Aside from dead people and rich people, what you have left is a tiny $352 billion tax cut for the balance of 145 million tax filers over the entire next decade.” The TCJA “is also undoubtedly the smallest, not the biggest, individual tax cut in history.” Nevertheless, the Tax Foundation has estimated that, “on average, taxpayers in every income group in every congressional district in America saw a net tax cut.” Although the TCJA’s corporate tax-rate reductions are permanent, because of the way the legislation was passed, the individual income rates reduced by the TCJA will expire in 2025. Even so, the Treasury Department has released 1,025 pages of regulations related to the TCJA, and is still in the process of finalizing some regulations related to enforcement and administration of the TCJA’s reforms. So much for the TCJA’s simplifying the tax code.

Undertaxed Americans?

Are Americans undertaxed? Those who tout the recent OECD report are certainly implying that Americans are. But three things should be noted about the report. One, it doesn’t actually measure individual Americans’ tax burden. It merely presents tax revenues in the United States as a percentage of GDP (the tax-to-GDP ratio). If taxes increase by some percentage, but GDP increases by a greater percentage, then it can be said or implied that taxes have decreased. Two, even if taxes in the United States are lower (according to the tax-to-GDP ratio) than every OECD country except Chile, Ireland, and Mexico, it does not necessarily follow that taxes in the United States are low in an absolute sense. And three, what about all of the other counties in the world that are not in the OECD? If taxes in the United States are compared with taxes in them, perhaps it will be seen that the tax burden in a majority of counties is actually lower than that in the United States.

But regardless of the OECD report, all of the 2020 Democratic presidential candidates think that Americans are undertaxed. They all favor a partial or total repeal of the Trump tax cuts and increased taxes on “the rich.” Some of them not only want to raise income taxes, but also to levy new taxes on accrued wealth. Sen. Elizabeth Warren of Massachusetts has proposed “a 2 percent annual wealth tax on individuals with more than $50 million in net worth, increasing to 3 percent on those with more than $1 billion in wealth.” But do “the rich” need to be taxed more? After all, they are the ones who already pay the bulk of the income taxes.

According to the latest figures released by the Internal Revenue Service (IRS),

In 2016, the top 50 percent of all taxpayers paid 97 percent of all individual income taxes, while the bottom 50 percent paid the remaining 3 percent.

The top 1 percent paid a greater share of individual income taxes (37.3 percent) than the bottom 90 percent combined (30.5 percent).

The top 1 percent of taxpayers paid a 26.9 percent individual income tax rate, which is more than seven times as high as what taxpayers in the bottom 50 percent (3.7 percent) paid.

“The rich” are also punished through the phase-out of tax exemptions, deductions, and credits as their income rises. And not only do “the poor” pay little or no income taxes, they receive tax refunds of money they never paid in, in the form of refundable tax credits. Even if the federal government just confiscated all of the earnings of every American who makes more than $1 million a year, that would run the government for only a little longer than four months.

The American tax burden

Americans are not undertaxed. They are taxed to death, and some are even taxed after their death. Americans as a whole are not only not undertaxed, some of them are quadruple-taxed on their income in addition to all the other taxes they pay. Aside from the personal income tax described above, there are two other significant federal taxes that all Americans must pay.

First is the Social Security tax. This is 12.4 percent (split equally between employer and employee) on the first $137,700 of employee income. The same income is taxed upon which is assessed federal income tax. And according to the Social Security Administration,

Some people who get Social Security must pay federal income taxes on their benefits. But, no one pays taxes on more than 85 percent of their Social Security benefits.

You must pay taxes on your benefits if you file a federal tax return as an “individual” and your “combined income” exceeds $25,000. If you file a joint return, you must pay taxes if you and your spouse have “combined income” of more than $32,000. If you are married and file a separate return, you probably will have to pay taxes on your benefits.

Then there is the Medicare tax. This is 2.9 percent (split equally between employer and employee) on every dollar of employee income. The same income is taxed upon which is assessed federal income tax and Social Security tax. There is also an additional Medicare tax of 0.9 percent that applies to income (including non-cash fringe benefits and tips) exceeding $200,000 ($250,000 for married filing jointly).

A federal unemployment tax of 6 percent is imposed on employers on the first $7,000 of each employee’s taxable wages during a calendar year. Each state likewise assesses employers an unemployment tax (less a credit against their federal tax liability). State unemployment taxes and wage bases are generally higher than the federal rate and base. Some states also require employees to pay state unemployment tax.

Other federal taxes include excise taxes on fuel, airline tickets, tobacco, alcohol, firearms, ammunition, and indoor tanning services. There is a federal tax per gallon of 18.4 cents for gasoline and 24.4 cents for diesel fuel. Domestic air travel is subject to a 7.5 percent tax on the ticket price, a $4.10 tax for each flight segment (one takeoff and one landing), and a “security fee” of $5.60 per one-way trip. There is a federal tax of $1.01 on each pack of cigarettes and small cigars, plus taxes on other tobacco products. The federal taxes on beer, wine, hard cider, and distilled spirits vary depending on the amount produced and the alcohol content by volume. Pistols and revolvers are subject to a federal tax of 10 percent of the sale price. Other firearms and ammunition are subject to an 11 percent tax. In addition to the medical-related taxes it imposed, the Affordable Care Act (Obamacare) also instituted a 10 percent tax on indoor tanning services.

And then, to add insult to injury, most of the tax money taken from Americans by the federal government is wasted on boondoggles and the welfare-warfare state. States and localities burden Americans with many taxes as well.

State taxes

Only nine states (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming) do not have a state income tax. Tennessee and New Hampshire tax dividend and interest income, but not earned income. In states with an income tax, the same income is taxed upon which is assessed federal income tax, Social Security tax, and Medicare tax. Nine states tax income at a flat rate, but most of them have a series of progressive tax brackets like the federal income tax. New York has eight tax brackets ranging from 4.0 to 8.82 percent. Hawaii has nine tax brackets ranging from 1.4 to 11 percent. California has ten tax brackets ranging from 1.0 to 13.3 percent, the highest in the nation. States without an income tax may simply shift revenue generation to other areas. Many of those states have high property taxes, sales taxes, gas taxes, or sin taxes, and some have steep vehicle registration fees. Nevada collects more than a billion dollars a year in taxes on gambling in Las Vegas and other areas in the state where gambling is legal.

Thirteen states (Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia) tax Social Security benefits. Seventeen states and the District of Columbia levy an estate tax or an inheritance tax. Maryland has both. Only five states (Alaska, Delaware, Montana, New Hampshire, and Oregon) do not have a sales tax. State sales taxes range from a high of 7.5 percent in California to a low of 2.9 percent in Colorado. Thirty-eight states collect sales tax at both the state and local levels. Only twelve states (Connecticut, Delaware, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, Montana, New Hampshire, Oregon, and Rhode Island) prohibit local sales taxes. Only six states (Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming) have no corporate income tax. Property taxes are found throughout the country.

Every state has taxes on fuel, tobacco, and alcohol in addition to federal taxes on them. Taxes on gasoline range from a high of 61.2 cents in California to a low of 14.66 cents in Alaska. Although most states exempt gasoline from sales taxes, some states collect both excise taxes and sales taxes on gasoline. State taxes on a pack of cigarettes range from a high of 44.35 cents in Connecticut and New York to a low of 30 cents in Virginia. Some cities, including Chicago and New York, also levy their own taxes on cigarettes.

Some of the more onerous state and local taxes are those imposed on hotel rooms and rental cars. Depending on the state and county or city, there might be state occupancy tax, local occupancy tax, tourism taxes, and convention taxes. Car rental fees might increase 20 to 30 percent after the addition of airport concession recovery fees, county rental taxes, state government surcharges, and consumer facility fees. And all of those taxes are in addition to the state and local sales tax that may also be imposed on hotel rooms and rental cars.

No, Americans are not undertaxed. The OECD Revenue Statistics report is highly misleading. Effective tax rates in the United States could be 50 percent, but as long as GDP is above a certain point, then it could still be said that Americans have a low tax burden if the United States is compared with selected other countries. That is ludicrous. Americans need tax relief, not tax reform.